Financial Seasonality: Seasons Impact More Than Weather

Seasonal changes impact more than the weather. You can see seasonal changes in financial markets as well. How can that be incorporated into a trading strategy? Are there trends that have already been established? We discuss all that and more in this episode.

Summary – Cents of Security Podcasts Ep. 63

The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.

Cassidy Clement 

Welcome back to the Cents of Security Podcast. I’m Cassidy Clement, Senior Manager of SEO and Content at Interactive Brokers. And today I’m your host for our podcast. And our guest is Steve Sosnick. He is the Chief Strategist here at Interactive Brokers, and he’s been a guest of handful of times on our show. 

So, we’re going to talk about seasonality in finance today. When we’re talking about that, we’re talking about the seasonal changes that can impact the market or that impact different stocks as you, or securities as you look at trends. So seasonal changes, we’re talking about more than the weather here. 

You can see seasonal changes in markets, incorporated into trading strategies, but really, we’re going to look at some or talk about some trends that maybe have been established. And then we’re going to discuss a little bit more of the underlying ideas that go into the research with seasonality. So welcome back to the program, Steve. 

Steve Sosnick 

Hey, Cassidy, great to see you again. 

Cassidy Clement 

Awesome. So let’s go right into it. So when we’re talking about financial markets, seasonality is more than just the leaves changing or what the weather is. How does seasonality go into market commentary and how people look at their strategies? What really is it? 

Steve Sosnick 

I think the first way you’ve got to look at it is via the economy. There’s always been seasonality to the economy going back to prehistory, right? Think of an agrarian economy and it definitely moves in cycles because you have, depending on where you are, summer, winter or wet season, dry season. 

And so that’s always been a factor and it’s human nature. Almost everything you can think about moves in cycles. And so it’s not a big stretch to think that extends into more modern aspects of finance.  

The difference here is it’s not perfect, whereas I could tell you with pretty good certainty in the northern hemisphere when spring and summer and autumn are going to start. 

I can’t necessarily tell you when things are going to start in the financial markets, but there is a bit of a tie to it and we can get into that, I’m guessing as we move along. 

Cassidy Clement 

Yeah, really, like, we can look at the word seasonality and we can easily attribute it to weather. We can attribute it to different types of behavior or like you were talking about cycles.  

I know in a previous podcast we were talking about something that’s cyclical versus non-cyclical but when we’re looking at this for the sake of investment, is this also something that’s going to vary from country to country or region to region? 

Steve Sosnick 

In theory, it should, because, obviously if you’re talking about like a summer cycle or fiscal years and stuff the southern hemisphere, for example, is in a completely different cycle than the northern hemisphere. And much of the world lives between the two tropic lines, and they don’t really have as defined of winter-summer seasonality that way. 

But it still extends to some extent also and I really do not mean to be U.S. centric, because I think that’s a very dangerous idea for investors, but essentially at this point in financial markets, the U.S. is driving the bus. You think about how much everybody is geared into U.S. tech stocks and U.S. stock markets, so for better or worse, we’ve exported our seasonality to a lot of the rest of the world. 

Cassidy Clement 

So since you’re our resident commentary guy, you have your videos, you have your highlights, you know the phrases of my next question very well. Seasonality comes in a lot of different contexts and also comes with a lot of different taglines, especially when we’re talking about different parts of the fiscal year, whether it’s the beginning or the end of a quarter.  

I think the most popular ones, if we’re going to go from the start of the year to the end of the year, is usually the January effect. Sell in May and go away in the spring, the summer doldrums in the summer, because people tend to be vacationing and such. The October effect and then finally the Santa Claus rally.  

So in the context of, we’ll say for this, the U.S., what are those common things that are referred to in commentary and financial news? And are there any others that I missed in my rattling off of the phrasing? 

Steve Sosnick 

I think you’ve gotten the bulk of them. So let’s try to unpack it. To me the granddaddy of them all is sell in May and go away because it encompasses pretty much all the other things that you’ve mentioned, which to me are subsets of that cycle.  

The basic premise is this- markets tend to open the year. Most years, in general, the stock market tends to go up whether we’re talking on a yearly basis or however you want to slice it over time. Just if you cut the year into days, more days are up than down. And so that’s basically the bias with which you look at the seasonality. 

So then when you break it apart, the selling may go away basically refers to the fact that there’ve been plenty of studies over time. And if you hold stocks in the six months, starting November 1^st  through May 31^st  and then went to cash for May 31^st through October 31^st ,I’m sorry, May 1^st through October 31^st, you generally outperform. 

Those six months tend to do better than the other six months. So let’s break it out. You mentioned the January effect. Essentially, there’s several thought processes and one is that there’s new money that flows into the markets at the start of the year.  

If you’ve been saving diligently and topped out your 401k throughout the year while you resume putting money into 401k in January. 

Also, it’s just natural for people to think in those terms, new year, new start of the cycle. It doesn’t always work. None of this stuff always works. I could think about January of 2022 where the high was hit on like January 3^rd and we never looked back. So these things are very much far from foolproof, but then the rally that peters out sometime in May. Part of that may have to do with the timing of taxes in the U.S.  

People, if you’ve had a good year and you owe money for taxes, that money’s got to be taken out on April 15^th. So if we think of money flowing in and out of the market as being a big driver, people are going to hold that money in the marketplace until the last possible second, because nobody really wants to pay their taxes early. 

And so it’s understandable why you may get this sort of seasonal rush that ends on April 15^th. Also, if you’re putting money into IRAs, that tends to happen. You could put in money into an IRA for last year up until April 15^th of the following year. So it all follows that tax cycle. 

So the money coming in tends to peak at that point, at least on a short term basis, and then you start to see some money coming out. So that’s the rationale behind the market taking a breather late April, early May. Also then you get into the summer doldrums. 

People in general, if you’re taking vacations, don’t want to be extending themselves too much on the risk parameters. You want to de risk a little bit. Do you want to spend your vacation worrying about your investments or would you rather just put them someplace where you can set it and forget it for a while? 

And so that’s part of a rationale why you see a little bit of a petering out in the summer. People tend to de risk a little bit. As you get into autumn, that’s a little bit flukier and that comes more to institutional investors than individual investors, but individual investors have to be aware of it. 

If you’re an institutional investor, you don’t want to be missing a rally and you want to get paid. Or if you’re a professional trader, you want to make sure that whatever money you made, you don’t lose.  

And so as a result, there’s an incentive among, among Institutional Investors and professional traders to de risk a little bit as you get into the September-October period, because nobody really wants to risk their bonus for the year by leaving it out there. 

And it’s often when stuff happens and to me, the best example of it was explained in my favorite movie that I’ve referred to a million times, my favorite stock market movie, Trading Places. And it takes place Christmas time, but Eddie Murphy sums it up well, when the Duke brothers are trying to teach novice Eddie Murphy how to trade commodities and I think it’s the pork belly market is plunging, and the Duke brothers want to buy the dip. 

Gee, that doesn’t sound at all familiar. And he tells them to wait, and his reason is because the traders are panicking, because they want to be able to buy their kids the G. I. Joe with the Kung Fu grip, and they won’t be able to do it, et cetera, et cetera, and of course the market sells off a little bit more. 

The Duke brothers, of course, because it’s a movie, catch the absolute bottom, thanks to Eddie Murphy.  

But I always do call it the G.I. Joe with the Kung Fu Grip Effect. People get nervous. Professionals get nervous in September and October, partly because they’re a little bit battle scarred, because stuff historically has happened in September and October. 

Think back about market crashes and stuff. They’ve tended to be at that time. And I do think a lot of that is driven by people getting nervous and freaking out about maintaining their bonuses as much as anything else. That gets us into November, And the September-October nervousness tends to be behind us. 

It does often present a buying opportunity. November of 2023 proved to be literally the absolute buying opportunity. End of October, first of November ‘23, was a fabulous buying opportunity. It rarely works that perfectly. And off we went into the end of the year.  

And the Santa Claus rally refers to.. specifically it’s meant to refer to the period between Christmas and New Year’s. And the reason being, if you were doing any end of the year tax selling, that’s generally behind you because people don’t really want to be trading into the last week of the year. There’s an old saying when you and I did adages, I think we did don’t short adult tape. 

Volume tends to evaporate because remember what I said about people wanting to be trading during Christmas time? Coverage on trading desks is light. Nobody really wants to be doing anything too much. So as a result, remember the first thing I said, markets tend to go up over time. 

And so if you’re ending the year on a decently positive note, that period tends to be positive. It doesn’t always work.  

I think it was 2018 or something like that, where that was an absolutely horrible period, but I think actually December bear market, I think terminated right before Christmas and then started to turn afterwards.I think we wrapped up the year in about five minutes there, Cassidy. Does that work? 

Cassidy Clement 

Yeah, that’s what we’re trying to do. Basically, take the entire timeline of the year and just shorten it into this little piece so we could explain all the different seasonality points. 

But those are basically the greatest hits, if you will, that you hear most of the time, but, you know, to go into that just a little bit deeper, you touched on it a little bit, which is if you think about this in the sense of more of a consumer behavior, too, you might have a holiday shopping or vacation timing or a back to school season, or maybe it’s in demand for a certain type of product. 

Those things can go into the cycle of the behavior and the seasonality of quite literally what season we are in. But you mentioned a few of these, but what are some examples that you can give to listeners, whether they’re market events or just a general idea that happens every year, whether it’s like a holiday or a stretch of time that is correlated to seasonality that we usually can see in the markets or that you happen to write about? 

Steve Sosnick 

If you think the most basic one is look at retail stocks and their earnings. A lot of people wonder why retailers tend to report earnings a little bit off cycle. With most companies, let’s say on an April, July, October, January cycle, retailers tend to be May August, et cetera. 

And the reason for that comes from Christmas season. And if you look at a retailer’s earnings, for the most part, tend to be a bit lighter in the first three quarters. And depending on what you sell, they may go up and down more or less based on, whether they tend to sell summer merchandise, etc., back to school season.  

But Christmas for the most part is the big kahuna for all retailers. And so as a result, rather than stopping their fiscal year on December 31^st, they tend to do it on January 31^st. And the reason for that being, post-Christmas sales and also returns. It would look very ugly if they had to account for people returning their merchandise early January and Their first quarter would look atrocious, so it balances out the effect. 

So that’s one.  

Let’s say a retailer’s earnings on a very seasonal basis. You have to either sum up the four quarters or do year over year comparisons, not necessarily quarter over quarter comparisons, because the fourth quarter with very few exceptions, and I can’t think of what those exceptions might be, will always look better than the third quarter. 

And the first quarter will always look worse than the fourth quarter.  

So that’s one of the things that’s very important to keep in mind. And this is a bit different, by the way, than, let’s say, the business cycle, which tends to operate over a period of years. And the Fed and other central banks have tried to do their best to smooth out the business cycle as best as they could. 

But these are cycles within the business cycle. I think we’re talking more about year over year cycles.  

The other one I forgot to mention was the January effect. And in better detail, there’s one other aspect to it and that is, think about December of 2022 and January of 2023, for a recent example. There was a lot of selling in December of 2022. As you get into the end of the year, if it’s been a bear market, and people are sitting on losses, the tax structure incentivizes you to take your losses early and let your winners ride.  

And so, a lot of people will start to take losses into December, if it’s been a bad year. And what happens is, again, that buy the dip comes back in and remember, buy the dip is not always foolproof, but this is one of these where there can be a reason and if people have been selling stocks to take tax losses, taxable investors are taking losses into the end of the year. 

A lot of times that does tend to reverse in January. And it’s not always even because, especially if you sold the stock and want to buy it back, consult your tax accountant for what I’m about to say, typically if you want to call it a long-term gain, you need to be out of the market for 30 days and same with wash sales. 

So a lot of times that sort of takes a little time from December to January for that to recoup itself. If some of those people want to get back in and buy the same stocks they sold to start to establish a new basis. But January effect tends to be more pronounced after you’ve had a rocky December. 

Cassidy Clement 

Yeah, I mean that example I think is perfect to show that there’s obviously tax implications to think about, there’s different strategies than with the company itself that you’re looking at or the general market sentiment is another big part.  

And then of course, if anybody’s been trading in the past four years, the unprecedented events, such as, COVID or recently with, I think it was Japan’s markets, there’s just so many different pieces that go into taking a list of observations of your investments or your idea for investments, on top of incorporating seasonality.  

So that kind of leads me into my next question, which is if somebody was going to be creating an investment strategy involving seasonality, what are some things to keep in mind outside of the obvious which is, what is your risk tolerance, what data are you looking at, et cetera? 

Steve Sosnick 

The most important thing to keep in mind is none of this works perfectly, and I know we just talked about this all for the better part of 15-20 minutes. The bad part about seasonality is it tends to work, but it’s far from foolproof. You get years that just blow out seasonality completely. 

2020 being an example. 2022 really not being cooperative. And, this year, 2024 up to this point, basically been buy, close your eyes, buy more, and then again, when in doubt, buy more. The seasonality aspect to it is very fluky. This stuff tends to work over time. 

And if you want to be doing anything involving seasonality, think about the reasons of why you’re doing it. There might be some money coming out to pay taxes, or you might have an oversold December, that kind of thing. Or the sell and may go away idea doesn’t actually tell you where to go or what to do. 

There’s a lot of flukiness to it. It’s one of these things that works until it doesn’t work, or it doesn’t work, and then it works again. So that’s unfortunately the most important part about it. We’re talking about things that over time, there’s certainly truth and there’s rationales to them, but none of it is perfect. 

Human nature is not perfect. If you’re doing a seasonality-based strategy, and it does involve human nature, and it does involve the here and now, not just the calendar. I’ve yet to find a perfect one. 

Cassidy Clement 

All the research that I’ve done when it comes to actually applying seasonality research is that it actually should be a supplement to other types of strategies because it works to convey more of the landscape of the market and incorporate some of the consumer behavior aspect. But as I mentioned, if you compare the last 50 years of data, there are certain chunks that you almost have to take out of the patterns because of the wild events that ensued. 

It wasn’t necessarily business as usual. The example, of course, is COVID is an easy one. 2008 is another one. There were different seasons that had huge market events that would have changed what would be a normal indicator to be something that maybe you would only see for a certain period of time until the market would not deflate, but the volatility would calm down a little bit more.  

But thank you so much for joining us, Steve. I know we always talk about seasonality when it comes to our line of work and stocks and data on the marketing team. So it’s great to have this chat. 

Steve Sosnick 

My pleasure, Cassidy. We’ll talk again whenever you come up with the next topic, I’ll be here for it. 

Cassidy Clement 

Of course. So as always, listeners can learn more about an array of financial topics for free at interactivebrokers.com and www.interactivebrokers.com. Follow us on your favorite podcast network and feel free to leave us rating or review. Thanks for listening, everybody. 

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